The Motley Fool: Marginal thoughts

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May 21, 2013
| Updated: May 21, 2013 10:22pm

A: High margins are generally preferable, of course. They can reflect some competitive advantages, such as a strong brand that commands a higher price. Amid a price war, companies with higher margins have more wiggle room. Still, you shouldn't necessarily avoid lower-margin businesses.

Imagine that Fred Co. (ticker: TAPTAP) has a whopping net profit margin of 25 percent, while Ginger Inc. (ticker: TWIRL) has just a 1 percent margin. If Fred sells only three top hats a year, while Ginger sells gobs of gowns each week, Ginger may well be the better buy, generating more cash in total than Fred.

Some industries, such as software, typically have high profit margins. Discount stores and supermarkets typically have very low ones - but if they turn over inventory fast enough, they might still be good investments.

Wal-Mart's margin, for example, is around 3.6 percent, while Target's is 4.1 percent. But Wal-Mart's volume is much higher, generating far more profit.

Foolish Trivia

Name that company

I was born in a one-bedroom apartment in Chicago in 1984, and today I have more than 3,000 employees and operations in 27 countries, providing independent investment research. The nation's shift from pensions toward 401(k)s boosted interest in mutual funds, so I began providing data on them. In 1985, I introduced ratings for funds. I went public in 2005. I cover more than 400,000 investments, including stocks, and I even manage money now, with about $157 billion in assets under management recently. I've bought companies such as Ibbotson Associates. I rake in more than $650 million annually. Who am I? Last week's answer: Stanley Black & Decker.

THE TAKE

A butterfly in the making

Caterpillar (NYSE: CAT), recently trading near its 52-week low, offers an opportunity to buy in at a good price and await the global economic recovery that will boost its stock price.

The company sports an extensive national dealer network and a widespread reputation for high quality. Its service network has allowed its market share to expand and keep customers coming back. It also enjoys a huge name-brand advantage, along with the sheer size of its company in an industry where both play a large role in success.

Caterpillar's short-term performance may be bumpy, but it will benefit from above-average long-term growth in regions such as China, India and Africa. With increased spending on industrialization and infrastructure building, there will be an increased demand for machinery and commodities. Meanwhile, Caterpillar's 2011 acquisition of Bucyrus, a mining equipment manufacturer, means that almost half its operating profits are now from the mining end market, where demand is expected to grow.

Another thing in Caterpillar's favor is its ability, so far, to avoid pricing wars with competition. This is evident in its quickest growing market - China - where it battles rival Komatsu for the dominant position.

With its dividend yield recently around 2.5 percent and its forward P/E ratio in the single digits, Caterpillar deserves some consideration for your portfolio.